Bank guarantees are indispensable in international trade. Due to stagnating economic growth in many European countries, numerous companies are coming under pressure.
This is resulting in unfulfilled trade contracts and disputes over bank guarantees that have been provided. Knowing what to look out for in such a dispute is crucial. Below, we compare the legal framework and the options available in Germany, France, Italy, and Austria, depending on the type of security and the role of the parties.
The German perspective of the guarantee creditor, the guarantee debtor, and the guarantee bank
In addition to documentary collection and bank guarantees, bank guarantees in their various forms are an established instrument for securing payment and performance obligations, especially in cross-border trade. In Germany, the “first demand” bank guarantee is the instrument of choice because it promises rapid liquidity. In contrast to accessory security instruments, the bank granting a “first demand” bank guarantee does not check the underlying claim before payment; it only refuses payment in cases of obvious abuse of rights.
However, companies acting as guarantee creditors are well advised not to make use of a guarantee on first demand without first checking the contractual requirements of the guarantee agreement and those of the underlying main contract. This can avoid a costly and time-consuming recovery process that could be initiated by the guarantee debtor. In this context, provisions on applicable law and international jurisdiction that may seem insignificant at first glance should also be carefully examined. Parties are often surprised by these aspects, for example when the beneficiary demands payment but is confronted with an “unfavorable” legal system in a strategically unfavorable jurisdiction that interprets the concept of abuse of rights too broadly. If the guarantee creditor concludes that the guarantee case has occurred, they should act quickly and without prior notification of the guarantee debtor and demand payment of the guarantee amount from the bank. Otherwise, the guarantee debtor could prepare an application for a preliminary injunction.
It may be advisable for the guarantor to apply to the court for a preliminary injunction against the bank or the contracting party in order to prevent payment of the guarantee amount. This may be appropriate if the solvency of the debtor itself is in question or if there is reason to fear that the contracting party will encounter payment difficulties during a lengthy recovery process. Whether a preliminary injunction is likely to succeed depends on the contractual provisions of the guarantee agreement between the bank and the beneficiary, as well as on the law applicable to this relationship. The guarantee agreement may contain detailed provisions that allow payment to be refused, such as the requirement for an (arbitration) ruling against the beneficiary. However, if the guarantee agreement does not contain such provisions, payment under a guarantee payable on first demand can generally only be prevented in cases of abuse of rights, which must be proven with “liquid” evidence. Such abuse could occur, for example, if the beneficiary and the bank had agreed to return the guarantee at a certain point in time, but the beneficiary claims the guarantee after that point in time. In any case, however, swift action is crucial, as the guarantee bank will usually pay out the guaranteed amount within a few days.
If the guarantee amount has already been paid out, the guarantor could contest the debit from its account if the payment was not authorized under the terms of the guarantee agreement or if there has been an abuse. In addition, the bank could be held liable for damages if it did not immediately inform the debtor of the claim, thereby depriving it of the opportunity to prevent the payment.
From the perspective of the guaranteeing bank, the utilization of the guarantee leads to a dilemma: on the one hand, the bank must fulfill its obligation under the guarantee to the guarantee creditor. On the other hand, it must observe its contractual relationship with the guarantee debtor and avoid payments without proper justification, as otherwise it would not be able to legally debit the recourse amount from the debtor's account. In addition to reviewing the relevant contractual documents and correspondence between the parties, it is advisable for the bank to allow a reasonable period of time to elapse before making the payment—in particular to determine whether a preliminary injunction has been issued prohibiting the payment of the guarantee. From an economic perspective, too, restraint often involves fewer risks, as the potential loss to the guarantee creditor usually consists of the costs of replacement financing (e.g., loan interest), whereas an unjustified payment can lead to the loss of the entire guarantee amount if a recovery later proves impossible.
A look at France
The bank guarantees commonly used in Germany also exist in French law. The instrument widely used in France to secure commercial transactions is the “garantie autonome,” which is very similar to the German “guarantee on first demand.” Like its German counterpart, the “garantie autonome” is abstract and independent of the underlying main contract and aims to provide quick liquidity. The “garantie autonome” is created by a unilateral declaration of the guarantor. It is important to ensure that its content is clearly distinguished from a bank guarantee (“cautionnement”), as otherwise there is a risk of the security being reinterpreted at a later date.
Claims under a “garantie autonome” must comply with all formal requirements specified in the guarantee declaration and with the guarantee conditions agreed in the main contract. Furthermore, under French law, payment may only be refused in cases of obvious abuse. According to French case law, this is the case, for example, if the beneficiary itself has not fulfilled its obligations under the main contract. Just as in Germany, French law allows the guarantor to file an urgent application for a preliminary injunction with the “juge des référés,” the competent judge, in order to prevent abusive claims. This approach is effective because it can significantly delay the enforcement of the guarantee, especially in cases involving substantial amounts or technical disputes, even though court decisions are usually handed down quickly.
From the perspective of the guarantee creditor, the French system is designed to promote the rapid enforceability of guarantees, with an emphasis on the abstract nature of the bank guarantee. In practice, however, the appropriate course of action often requires careful consideration of the interests of the debtor and the bank, as rapid payment is not always guaranteed.
From the bank's perspective, the legal obligation to pay is clear, but in practice banks act cautiously to avoid liability for unlawful claims. As a rule, they notify the debtor after receiving a request and temporarily withhold payment of the guarantee amount to give the debtor time to act, adding another layer of timing and strategy to the entire process.
It should also be noted that in some disputes, French courts have applied French law to disputes over guarantees when French law governs the main contract, even though the guarantee agreement was expressly subject to another law.
A look at Italy
In Italy, the “garanzia autonoma” or “garanzia a prima richiesta” is widely used, particularly in public procurement and commercial contracts. Like its German and French counterparts, it is a non-accessory guarantee, meaning that defenses arising from the main contract cannot prevent payment. As in France, precise wording in the guarantee declaration is essential to avoid reinterpretation as an accessory guarantee, which carries the risk of defenses arising from the main contract.
Before paying out, Italian banks only examine two narrowly defined exceptions (“exceptio doli”): fraud and abuse. As a result, the guarantor has little leeway for early intervention. Unlike in Germany and France, preventive legal remedies through preliminary injunctions are rare in Italy and subject to strict requirements, in particular a high burden of proof. Furthermore, Italian courts tend to emphasize the purpose of the “garanzia autonoma” as an instrument for obtaining immediate liquidity, so that preventive judicial control of guarantee payments is rarely granted. Consequently, legal protection for the debtor in Italy is largely reactive in the form of claims for reimbursement or damages after payment has been made.
Accordingly, the autonomous guarantee offers highly effective and immediate protection against the risk of non-performance for the beneficiary of the guarantee. The bank's obligation to pay on first demand provides confidence and liquidity without the delays caused by litigation or proof of breach. However, this autonomy has limits: the beneficiary must act in good faith and not abusively, as fraudulent or opportunistic claims may trigger the “exceptio doli” and lead to liability for damages.
The guaranteeing bank is obliged to pay on first demand, provided that the formal requirements are met. While this ensures efficiency in business relationships, it also exposes the bank to payment risks, especially if the debtor has not fulfilled its obligations. The bank's protection is then limited to cases of “exceptio doli.”
A look at Austria
In Austria, bank guarantees play a minor role, primarily due to the local government “stamp duty” of 1% of the secured amount, which is payable by the guarantor. Not least for this reason, the “on first demand” guarantee is the preferred security for Austrian commercial contracts and construction projects. Like its counterparts mentioned above, the Austrian version is also non-accessory. In addition, Austria has what is known as a “simple guarantee,” which is generally abstract but requires the beneficiary to prove that the secured event has occurred before payment is made. However, since it is not payable on first demand, it is of little practical significance.
A typical dispute in connection with a guarantee on first demand in Austria arises when a building contractor instructs its bank to issue a guarantee in favor of the customer to secure the construction work. The bank undertakes to pay the customer—the creditor—upon first written request without further examination. If the customer later demands payment on the grounds of a defect or delay, the bank must pay immediately—regardless of whether there is actually a defect or delay or not. The contractor, as the guarantor, cannot directly object to the bank's payment, but must instead take legal action against the client. This illustrates the central principle of Austrian law: “pay first, then litigate.”
In disputes over collateral, the available legal remedies and strategic considerations correspond to those under German law. The debtor can apply to the court for a preliminary injunction to block payment. Under Austrian law, it remains controversial whether the bank must notify the guarantor before making the payment in order to enable a preliminary injunction. In practice, however, banks regularly request a statement from the guarantor before making payment as part of their contractual duties of care and loyalty.
Procedure in the event of a dispute
The comparison shows that the abstract “first demand” guarantee and its counterparts are the preferred security instrument in all the jurisdictions compared. The legal remedies available to the parties involved and the strategic considerations in the event of a dispute are also largely similar:
For the guarantee creditor, the most important recommendation is consistent: The guarantee should not be invoked without first carefully reviewing both the guarantee agreement and the substantive requirements of the main contract. This is the only way to avoid costly recovery proceedings. In this context, the provisions on applicable law and international jurisdiction should also be carefully examined in order to avoid unpleasant surprises. Once the guarantee event has occurred, the creditor should act quickly and demand payment of the guarantee amount from the bank before the guarantor can prepare a preliminary injunction.
For guarantors, a preliminary injunction before state courts can be an effective and expedient means of preventing payment – with the caveat that Italy offers only limited preventive legal protection. When assessing their position, debtors should carefully examine the scope of the guarantee, the obligations covered, any deadlines, and the conditions for returning the security. If the guarantee is called upon at a time when the beneficiary is already obliged to return the guarantee, the debtor could successfully claim abuse of rights. In practice, the debtor must also be aware that there is usually only a short window of opportunity to prevent payment – so swift action is essential.
From the perspective of the guaranteeing bank, in addition to thoroughly reviewing the most important documents, it may be advisable to wait a reasonable amount of time before paying out the guarantee amount, as a preliminary court order for payment could be issued in the meantime.
Authors:
Thomas Frad - KWR
Stephan Bausch - Luther
Borbála Dux-Wenzel - Luther
Stephanie Quaß - Luther
Manuel Tomas - Fidal
Francesca Proietto - Pirola
